In a typical scenario, some companies can achieve a degree of liquidity by offering shares in the company on a stock exchange. In such a case, an investment in the company comes with risks to the investor that are not only related to the industry, but also to the company itself. Such risk may stem from the potential of mismanagement of the company, loss of key employees, and so on. Individuals, or funds, may purchase shares in a variety of companies in an attempt to offset any idiosyncratic risks attributable to individual companies. But, in the end, the investors risk is still a function of the individual performance of the companies of which he owns shares.
While many companies can gain liquidity through “going public”, some companies or other entities do not meet the investment community's requirements to do so. For example, in some situations, small business owners may desire to sell part of their business for diversification purposes or to raise capital to invest back into the business. This can be difficult with a small, privately held business. Capital markets are not open to the small businesses because of their size and lack of accounting audits. So this path remains unavailable to small businesses, while being quite available to many larger businesses.
Small businesses can sometimes sell a stake, ranging from a minority stake to up to a 100% stake, to private investors or private equity firms, but they tend to sell at a low price to earnings ratio. And, the terms of such investment can often be considered unattractive to the small business. For example, a certain amount of control of the small business may also be required in the exchange for capital from the investor. On the other hand, investors who might benefit through investments in these businesses do not have a convenient liquid way to do so. Typically, to buy into a small business an investor must go through a fairly involved and costly assessment process. And, selling the stake in the small business may also be a complicated and lengthy process.
In the case of real estate, financing to purchase or refinance a property is typically accomplished by taking out a mortgage loan. The interest rate of the mortgage loan is based on the prime lending rate. The mortgage loans are typically either fixed rate or adjustable rate. With fixed rate loans the interest is fixed for the life of the loan, so the monthly payments are fixed for the life of the loan, although the last payment may be marginally different from the others. With adjustable rate mortgage loans the interest rate may be fixed for an initial period (e.g., 3 years) and then adjusted periodically thereafter. The adjustment is based on changes to the prime lending rate. With these loans, the borrower's payments can change significantly once the loan goes into adjustment. Borrowers typically try to refinance to a fixed rate mortgage loan when this happens if the rates have increased materially. However, if relevant real estate values have decreased the borrower could end up with very little equity or even negative equity in the property—which can be an insurmountable impediment to refinancing. Therefore, the borrower could be left with adjusted mortgage loan payments that it can not afford to make, which can ultimately lead to foreclosure.